Treasury report on banking/fintech relationship includes recommendations for CFPB oversight of non-bank lenders and data aggregators

The Treasury Department has released a report titled “Assessing the Impact of New Non-Bank Entrants on Competition in Consumer Financial Markets.” The report was issued in response to President Biden’s July 2021 executive order to promote competition. This order directed the Treasury Secretary to issue a report assessing how the entry of large technology companies and other non-banks into consumer finance markets has affected competition. The report focuses on fintech and other emerging “non-incumbent” non-banks directly involved in providing digital financial products and services in the core consumer finance markets of deposits, payments and credit. The report looks at the role of these non-bank newcomers, how they interact with insured depository institutions (IDIs), and their impact on these core markets.

Unlike the CFPB, which has often placed more emphasis on potential consumer risks of financial technology-related advances than potential consumer benefits, the Financial Report takes a more even-handed approach. For example, while the report addresses the potential risks of new insurance approaches that use new technologies, it observes that “[w]Although policymakers must address the potential risks posed by these new technologies, a broad rejection of potential new forms of consumer credit insurance is not costly to consumers who are inadequately served by the status quo.” It also notes that “[a] lack of sufficient clarity regarding the application of existing laws or supervisory standards to available credit underwriting approaches may affect the willingness of responsible lenders to use these approaches.” In particular, the report’s recommendations deserve attention because they are likely to influence future actions by the federal banking regulators and the CFPB. (The report is also worth reading for its discussion of the role of fintechs and other non-banks in providing financial services to consumers and how that role has evolved.)

While the report does not address “real lender” challenges in bank/fintech lending relationships, it does discuss the risk of “so-called ‘rent-a-charter’ schemes that market themselves as innovative fintech lending platforms but operate primarily with same harmful business model as a traditional lender.” The report attributes the risk that such arrangements will arise to banking/fintech relationships that “lack proper regulatory oversight or principles for responsible lending”. The report shows that “[i]In addition to unreasonably priced credit, ‘rent-a-charter’ lenders distribute products using other practices that are both unsafe and unreasonable for the lender and unfair to consumers. Likewise, high-cost, high-standard loan programs that do not adequately consider a borrower’s financial capabilities may warrant review for unsafe or unsound practices and violations of laws, including consumer protection statutes, and inconsistencies with supervisory principles for responsible consumer lending.” The report’s recommendations discussed below that target bank/fintech lending relationships are intended to make such relationships “using the privilege of an IDI … subject to regulatory standards for responsible consumer lending programs.”

We urge that rather than focusing on which party in a banking/fintech relationship has the predominant financial interest, Treasury’s focus, as reflected in the recommendations, is whether the lending activity is subject to adequate supervision and regulation. While acknowledging the validity of concerns that banking/fintech relationships could devolve into “rent-a-charter” arrangements involving harmful lending practices, the report indicates that these concerns are mitigated if loans must meet the same underwriting and lending standards as all second. other loans from the bank. Referring specifically to concerns about usury and interest exports, the report recognizes “an adjustment of incentives if all aspects of the lending activities are regulated and monitored as if they were conducted by the IDI.” This suggests that the Ministry of Finance recognizes that regardless of the predominant economic interest, preemption and interest export may be appropriate for loans granted through a bank/fintech relationship if the supervisory and regulatory controls that apply to loans originating from this relationship are the same as those that apply. when the bank grants loans through another channel.

The report distinguishes “incumbent non-banks” from “non-incumbent non-banks”. Incumbent non-banks are short-term credit providers such as mortgage and title lenders, specialist installment lenders such as captive finance companies, non-bank lenders, money transmitters and card networks. The new non-bank players that the report focuses on are “non-incumbent non-banks” consisting of:

• Big Tech companies, meaning large technology companies whose primary activity involves the provision of platform-based digital services;
• Fintech companies, which means companies that specialize in providing digital financial services to consumers or enable other financial service providers to provide such services to consumers; and
• Retail companies, i.e. non-bank newcomers who are not fintech or Big Tech companies.

The report is divided into six parts:

• Overview of the current market landscape, which includes a discussion of the deposit, payment and credit markets and how IDIs and non-banks are regulated and supervised
• Assessing impacts on competition, which includes a discussion of the role of new non-bank entrants in unbundling or unbundling the core banking services offered by IDIs by focusing on a single product or service, as well as the recent trend of re-bundling of multiple product offerings on a single platform, the reasons for the popularity of non-bank/bank partnerships, and competitive trends in the payment, deposit and credit markets.
• Opportunities and risks, which include a discussion of:
  • whether and how, based on available documentation, new non-bank entrants serve customers that IDIs do not have by expanding access to credit, payment services and deposit services. (In terms of deposits, the report only discusses digital or new banks that exist both as IDIs and non-banks partnering with IDIs).
  • The following risks:
    • Prudential concerns arising from the re-bundling of functions in banking;
    • Mixing of trade and banking arising from non-banks seeking banking charters;
    • Reliability and fraud in digital financial services;
    • Data protection and security in connection with increasing demand for consumer data;
    • Bias and discrimination arising from artificial intelligence/machine learning models; and
    • Consumer financial well-being as a factor in products and services offered by non-banks.
  • Outstanding gaps in reaching low-income individuals.
• Potential Impacts on Competition: Big Tech in Consumer Finance.
• Recommendations, which include the following:
  • To enable competition in responsible consumer credit insurance, the Treasury Department recommends that federal banking regulators should take various steps, including:
    • Use the existing model risk management supervisory framework to provide further clarity and consistency across IDIs regarding the use of alternative data and new complex algorithms in credit guarantee systems. This includes IDIs acting as lenders in bank/fintech partnerships.
    • Continue to work with supervised institutions that are trying to implement new credit underwriting approaches, including those that use alternative data. New collateral approaches that are appropriately designed to increase credit visibility, reduce bias and expand access should be supported.
    • Assess current guidance for credit underwriting, fair lending and consumer lending to identify potential gaps relevant to the implementation of model risk management oversight, including the lack of guidance that would be useful to an IDI in developing risk management processes for collateral approaches and related products that use alternative data or new complex algorithms. Given that IDIs often rely on credit models provided or supported by a third party, it may be important for regulators to clarify or reiterate expectations regarding the levels of model validation and monitoring documentation sufficient to evaluate compliance with third-party credit scores and models with consumers. laws and other risk management standards that apply to IDI activities.
    • Continue to coordinate with the CFPB and other relevant federal agencies regarding principles and practices to identify and mitigate Fair Lending Act violations by IDIs and non-bank lenders that use alternative data in underwriting.
  • To enable effective oversight of banking/fintech relationships, Treasury recommends:
    • To help reduce regulatory gaps and maintain a level playing field, the CFPB, HUD, and FTC may need to act with respect to the activities of fintechs and other non-banks that provide services critical to bank/non-bank relationships to help to ensure that the parties in such relationships are appropriately monitored and held accountable for offences.
    • The Federal Reserve, FDIC, and OCC should finalize the interagency guidance for banks on managing risks related to third-party relationships that was proposed in July 2021. This would serve the goal of establishing a clear and consistently applied supervisory framework for third-party relationships, including bank/fintech relationships. When finalizing the guidance, regulators should include language to help encourage IDIs to negotiate effective oversight provisions in their contracts with third-party providers, such as provisions requiring a third party to follow certain compliance and risk management practices that would not otherwise be applicable . to the third party if it was not in a relationship with IDI, and to provide IDI with access to information necessary to assess whether the third party’s activities comply with all regulations and risk management policies to which IDI’s business is subject, such as fair lending rules.
  • With respect to bank/fintech lending relationships, the Treasury Department recommends that federal banking regulators take the following steps “to increase consistency in supervisory practices, such as examination practices, related to small dollar lending programs”: (1) revise the interagency small dollar. lending guidance issued in 2020 to address coverage of larger loans (eg loans of $10,000 or more) and address with greater specificity how the guidance applies to a bank-fintech lending relationship, including the activities performed by a fintech or other third party with or on behalf of an IDI lender, and (2) provide IDIs with more specifics on how to offer small-dollar loan products or related products while complying with applicable laws and regulations.
  • With respect to alternative forms of non-bank lending, the Treasury Department recommends that the CFPB should (1) continue to examine and monitor developments related to small-dollar installment loans (such as buy-now, pay-later (BNPL)) and consider what additional guidance may be appropriate, ( 2) consider whether and how the CFPB might supervise larger non-bank lenders, including providers of BNPL and installment loans (which the CFPB had considered under former Director Cordray, but abandoned under former Director Kraninger); and (3) return to its 2020 Advisory Opinion on Earned Wage Access Programs and consider whether products that meet the requirements of the Advisory Opinion should not be considered credit products subject to TILA and Rule Z.